In this post, we'll focus on the most controversial aspect of the Act - losing the "stretch" for inherited retirement assets - and what you can do to make the most of it for your beneficiaries.
Here's the punchline: Before the SECURE Act, non-spouse beneficiaries, like your kids, could inherit IRAs and 401(k)s and "stretch" out the required minimum distributions over their own life expectancy. This helped minimize the income tax consequences to the beneficiaries and allowed for continued tax-deferred growth inside of those accounts. But now, with few exceptions*, beneficiaries only have 10 years following your death to distribute the entire amount, creating, in some cases, some serious unintended tax consequences.
(*surviving spouses; minor children until age of majority; individuals within 10 years of your age; individuals with chronic disabilities)
What are you supposed to do if you have heavily invested in qualified retirement plans and you want to avoid those consequences? Can you protect the assets? Can you reduce or eliminate the taxes?
Below are five of the best options to accomplish those goals in light of the new Act. If you have other ideas or questions, please feel free to share them here.
You should not act on any of these ideas until speaking with your financial advisor and estate planning attorney to ensure it's the right fit for your particular situation.
1. Add more beneficiaries, such as your grandchildren. If both your children and grandchildren are named as beneficiaries, each of them would inherit a smaller portion of the retirement assets. This means that each beneficiary is bearing a smaller individual tax burden at the end of the 10 year period. And if any grandchildren are minors, they have additional time to allow for tax-deferred growth.
2. Designate a spouse AND children (or other individuals) as simultaneous beneficiaries at your passing, rather than naming spouse as primary beneficiary and all others as contingent beneficiaries. Statistically, you and your spouse will not die at the same time. The surviving spouse may not die for more than 10 years after the death of the first spouse. If beneficiaries are structured properly, this creates two 10-year periods for your non-spouse beneficiaries to spread out the required minimum distributions and associated taxes.
3. Considering Roth conversions. Converting Traditional IRAs to Roths can help solve the income tax issues by absorbing those taxes now rather than putting them on your beneficiaries. The money is going to be taxed at some point, so we should identify when the tax burden is likely to be the lowest - during your lifetime or when your beneficiaries inherit? If your beneficiaries are going to be inheriting during the years when their income is likely to be its highest, Roth conversions may be worth considering.
4. Purchase life insurance. It wasn't very long ago that a relatively modest amount of savings were likely to result in estate taxes upon death. Many people purchased life insurance policies specifically designed to replace any "lost" inheritance that was used to pay those taxes. Under the current tax laws, very few people will have an estate large enough to owe estate taxes at death, but the life insurance principal is still sound. If you fear that losing the stretch under the SECURE Act is going to cost your beneficiaries quite a bit in taxes, you can purchase a life insurance policy to replace the estimated value of those taxes.
5. Create a Charitable Remainder UniTrust, or CRUT. This is the most complex option, but it will be a good fit for many families now that the SECURE Act has become law. The CRUT allows you to spread retirement distributions (and income taxes) over the life of your beneficiaries, just like before the new law was enacted. The CRUT names an ultimate charitable beneficiary to eventually receive the retirement assets, but only after your individual beneficiaries have died. Until then, the CRUT will pay out a percentage of retirement assets annually - between 5% and 50% of the principal - to your individual beneficiaries. These distributions are taxable income, but rather than making the distribution in 10 years, it can still be stretched over their lifetimes. And at the end, you make a tax-free distribution of remaining assets to a charity of your choosing.
As time goes on, we're sure we'll learn of additional strategies. When we do, you'll be the first to hear about it.
Here's the stuff we always put at the end:
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Disclaimer: Reading this blog post does not create an attorney-client relationship, and it is not formal legal advice. This is for information purposes only. It is always best to speak with an attorney about your questions, assets, concerns, and needs.